Puerto Rico Testing Investors Following Worst Loss

Puerto Rico’s debt lost about 20 percent last year, the most since at least 1999, and about eight times more than the decline for the entire market, S&P data show. Photographer: Christopher Gregory/Getty Images

Jan. 6 (Bloomberg) -- Puerto Rico, with $70 billion in
government and agency debt and its economy contracting, faces
the first test of investors’ willingness to buy its long-term
securities with a plan to offer bonds following a thwarted 2013
offering.

The U.S. commonwealth, with a credit rating on the brink of
junk and a murder rate double Chicago’s, plans to issue an
undetermined amount of long-term debt this month or in February,
according to Alix Anfang, a spokeswoman for the Government
Development Bank in New York.

Soaring yields sandbagged a plan in the fourth quarter to
sell as much as $1.2 billion of debt backed by sales taxes,
called Cofina bonds after a Spanish acronym. While Governor
Alejandro Garcia Padilla says the territory and its agencies
will repay their obligations on time and in full, an economy
that contracted in six of the past seven years casts doubt on
that promise. Investors last week were demanding record yields
to buy Puerto Rico debt.

“The Cofina deal is one of those very crucial elements
that they need to do to retain their credit standing,” said
James Dearborn, head of munis in Boston at Columbia Management
Investment Advisers, which oversees $30 billion of munis and
owns Puerto Rican debt.

No Bankruptcy

Like Dearborn, investors far beyond the Caribbean island
are watching Puerto Rico’s financial health. More than three-quarters of U.S. muni mutual funds hold its securities, which
are tax-free nationwide. While the commonwealth isn’t eligible
to file for bankruptcy, a default on its bonds could dwarf
Detroit’s record $18 billion bid for Chapter 9 protection in
July.

The island’s debt lost 20.5 percent last year, its worst
year since at least 1999 and about eight times more than the 2.6
percent loss in the $3.7 trillion municipal market, Standard &
Poor’s data show. Yields, which move inversely to prices, may
increase further, said Robert Amodeo at Western Asset Management
Co. in New York.

“It’s the weak economy,” said Amodeo, who helps manage
$30 billion of munis, including debt from the island.

Puerto Rico sales-tax bonds maturing August 2039 and rated
four steps below benchmark munis traded Dec. 30 with an average
yield of 9.13 percent, a record high and 5.44 percentage points
above top-rated munis, Bloomberg data show. That’s the biggest
gap since the debt first sold in June 2009.

‘Continued Progress’

“In 2014, we will continue to focus on the factors that
are under our control and strive to make continued progress in
strengthening Puerto Rico’s fiscal situation and liquidity,”
Jose Pagan, interim president of the Government Development
Bank, said in an e-mail.

Yet the island, where Census data show the median household
income in 2012 was $19,515, less than half of the U.S. figure,
has fewer people to repay its liabilities. As residents have
migrated to the mainland, the population dropped almost 1
percent in 2013 to 3.6 million and has declined each year since
2005, according to Census data.

Crime preys on those remaining. Puerto Rico had 859 murders
in 2013 through Dec. 15, a 7.4 percent decline from 2012,
according to the newspaper Caribbean Business. Even with the
drop, the homicide rate is more than double Chicago’s, which had
the most killings among large U.S. cities last year.

Index Drop

An index that tracks the island’s economic activity
contracted in November by 5.7 percent compared with the same
month in 2012, according to the Government Development Bank.

Moody’s Investors Service Dec. 11 threatened to cut Puerto
Rico’s general-obligation bonds to junk within 90 days. Fitch
Ratings said it may also lower the island’s general obligations
to junk by June 30.

John Miller, co-head of fixed income at Nuveen Asset
Management LLC in Chicago, which oversees $90 billion of munis,
has kept the firm’s allocation to Puerto Rico at about 1.25
percent. Some Puerto Rico general obligations are trading as low
as 57 cents on the dollar. If the economy improves, prices could
jump by 10 cents, yet a downgrade could cause them to drop just
as much, Miller said.

“It’s just really difficult to get comfortable,” he said.

Garcia Padilla, 42, who took office a year ago, has taken
steps to maintain the island’s credit rating. The governor and
legislature last year boosted the retirement age for public
workers and teachers, asked them to contribute more to their
pensions and curbed benefits. The governor wants to end deficits
in the fiscal year starting July 2015.

Job Target

“If they are able to bring a new deal with something very
very close to a balanced budget, the optimistic side of the
story is maybe they could avoid a downgrade in the first half of
the year,” Miller said.

This week, states and cities plan to sell about $2.2
billion of long-term debt, Bloomberg data show.

Benchmark 10-year munis yield 2.99 percent, down from a
three-month high of 3.05 percent on Dec. 11 and is on par with
similar-maturity Treasuries.

That makes the ratio of the interest rates, a gauge of
relative value, 100 percent, compared with a five-year average
of 101 percent. The lower the figure, the more expensive munis
are compared with federal securities.